Treasury has warned the budget will be under heavy pressure over the next two years because falling commodity prices are hurting corporate earnings.

Officials led by Treasury secretary
Martin Parkinson
forecast nominal economic growth – a measure of what the nation is paid for what it produces – will remain below the historic average over the next two years.

In a sign that the issue is becoming a serious threat, Dr Parkinson said yesterday that Treasury would devote more resources to understanding the effects and drivers of the slowing nominal economy.

Nominal gross domestic product growth was weaker than real GDP in the three months to September 31 for only the sixth quarter in 53 years, he said. Slower nominal growth, largely due to the falling terms of trade, is bad news for the Gillard government and a potential Coalition federal government as it means tax revenues will be weaker than during the boom years.

Just as the rising terms of trade between 2003 and 2008, and 2010 to 2011, helped to super-charge company profits and government tax revenue, the opposite is true as they fall.

Treasury’s head of macro-economics, David Gruen, said: “If you’re looking for a single indicator [of what] the government collects, then nominal growth is the thing to look at and it’s growing particularly slowly at the moment." The slump in nominal growth in the September quarter was a key reason cited by Treasurer
Wayne Swan
for scrapping Labor’s long-anticipated budget surplus for 2012-13.

Speaking at a Senate estimates hearing yesterday, Dr Gruen said the declining terms of trade – a measure of earnings from exports – would weigh on nominal growth even though real GDP would keep expanding at its “trend rate". “It’s the dollar value of output that’s relevant, rather than real GDP, which is the measure of volume of production," he said.

Dr Parkinson said the falling terms of trade created a “higher and higher imperative" to raise productivity growth. He said he agreed entirely with a warning this month by prominent economists Bob Gregory and
Ross Garnaut
that Australians faced an adjustment to their standards of living as commodity price gains fell.

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The Reserve Bank estimated last week that the terms of trade have fallen 17 per cent since their peak in September 2011. Treasury expects that to continue, despite recent commodity price gains. “Over the past decade, around about half of the growth in living standards per capita has come from the terms of trade," Dr Parkinson said.

The high dollar was another factor exacerbating the impact of the falling terms of trade. “We’ve seen the terms of trade ease off as commodity prices have fallen. We would traditionally have expected the exchange rate to have fallen significantly as well.

“The fact is the exchange rate has stayed up. What that means for firms in the mining sector where their revenue is in US dollars and their costs are in Australian dollars, is they’re getting their margins squeezed. So it’s a profit squeeze that’s flowing [through government revenue]," he said.

He said a review of Treasury’s forecasting performance will be released in a couple of weeks. It was conducted by a team from the department and seen by an independent group that included RBA assistant governor
Malcolm Edey
and Access Capital Advisers chairman
David Chessell
.

Dr Parkinson said the review found Treasury’s performance in economic and revenue matters were broadly comparable to those of similar agencies in Australia and overseas. It has made 11 recommendations including a greater focus on analysing nominal growth. “Understanding what has happened to nominal GDP is really quite challenging," he said.

In comments that echo warnings from RBA governor Glenn Stevens in an interview with The Australian Financial Review in December, Dr Gruen questioned whether the economy’s transition from a dependence on resources investment to other sources of growth would be as smooth as official forecasts implied.